Expansionary Policies in the Nordics
Jul 19, 2006
Thomas Gade (London) and Elga Bartsch (London)
Strong growth and low inflation. In recent years, the Nordic economies have outpaced the euro area economy in terms of real GDP growth. At the same time, consumer price inflation in the region stayed below that of the euro-area bloc. Although we expect a general economic slowdown in 2007, the outperformance of the Nordics versus the euro area is likely to continue, we think. The strong overall performance of the region masks considerable country differences in terms of GDP growth ranging from fast expanding Sweden and Finland to a steady growing Norway to an already slowing Denmark.
Expansionary policy mixes. The growth differentials are at least partially linked to variations in the macroeconomic policy mix between monetary and fiscal policy in the region. Despite monetary policy being gradually normalized everywhere at the moment, both monetary policy and fiscal policy are currently more expansionary in the Nordic region than they are in the euro area or the UK. Within the Nordic region, the policy mix ranges from a very stimulative combination of expansionary monetary and fiscal policy in Sweden to a more moderate stimulus in Finland. Denmark and Finland no longer have an independent monetary policy. Finland is part of the euro and Denmark has pegged its currency to the euro. Only the Riksbank and Norges Bank pursue an independent monetary policy. Due to low consumer price inflation and their inflation-targeting policy framework, interest rates remain some 225 basis points below the neutral level in both Sweden and Norway, compared to shortfalls of only 75 bp in the euro area and a mere 50 bp in the UK. Next to higher trend rates of GDP growth, this expansionary policy mix is a key reason for the higher growth rates we are forecasting for the Nordic region. Sub-neutrality feeding lending growth. The expansionary monetary policy stance is also reflected by money demand dynamics, as across the region money supply continues to expand at double-digit growth rates. Going forward, money demand and credit expansion as well as house price appreciation are expected to slow as monetary accommodation gradually is withdrawn. We expect the Riksbank to continue normalizing monetary policy by at least another 50 bp by the end of this year to 2.75%. The risks for a total of 75 bp remain on the upside, we believe. In Norway, the Norges Bank is continuing the gradual pace of normalization in small, not too frequent steps. The market is currently split between two or three more rate hikes for the reminder of this year. Currently risks are favoring three, we think. This would place the main monetary policy rate in Norway, the sight deposit rate, at 3.50% by year-end. In Finland and Denmark, the ECB will in principle do the monetary normalization. We expect the ECB at 3.50% by year-end. While we expect the ECB to pause at 3.50%, we expect monetary normalization to continue towards neutrality in Norway and Sweden. In Denmark, the ECB’s tightening pause could fuel further an already heated economy. Rising inflationary risks. Despite the ongoing monetary normalization, we would highlight that both the Riksbank and Norges Bank are still far away from a neutral policy stance, let alone a restrictive one. We would expect this to remain the case over the forecast horizon because inflation in the Nordic region has remained very contained thus far. However, there is a risk that the current expansionary monetary policy as well as fiscal policy stance will lead to rising wage pressures in the future. Due to the still relatively widespread multiyear wage deals, this risk might take some to develop. If it does, inflation could potentially overshoot the central banks’ targets. This risk is particular pressing in Denmark, Norway and Sweden, we think. For the latter two, it could potentially cause a monetary policy response. This, however, is likely to be a story for late 2007, we think. In Denmark, where the central bank shadows the ECB, higher wages would likely lead to losses of price-competitiveness and hence of market share. There are some indications — such as relative unit labor costs and relative export performance — that this process might already have started.
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Price Dynamics at Mid-Year
Jul 19, 2006
Denise Yam (Hong Kong)
More details on June price indices: Headline price indices released earlier suggested a pick-up in overall inflation in June due to a renewed upsurge in raw material prices. The CPI (+1.5%), RPI (+1.6%), PPI (+3.5%), raw materials purchasing price index (RMPPI) (+6.6%) and corporate goods price index (CGPI) (+2.3%) all showed larger increases than in May. The NBS released a detailed breakdown for the CPI, PPI and RMPPI today. Consumer level inflation (+1.5% YoY) was little changed from the previous month (+1.4%), with larger increases seen only in grains (+2.2% vs +1.7%) and intercity transport fares (+6.5% vs +5.8%), while the rise in utility costs actually eased (+5.3% vs +6.1%). Producer level inflation (+3.5%) was lifted primarily by raw materials (+8.5% vs +6%), while consumer goods (-0.2%) continued to leave factories at lower prices than the year ago period. Within the raw materials space, the cost of fuels (+14.1% vs +11.8% in May) and non-ferrous metals (+36.9% vs +35.3%) continued to surge ahead, more than offsetting the continued drop in ferrous metals prices (-2.4% in June, -2.5% in 1H) and the stagnant trend in chemical materials prices (+1.6% in June, +0.6% in 1H). What is happening to margins? We study the differing trends in the reported price indices and deduce simple proxies for manufacturers’ margins. We have been arguing that overcapacity and competition at the downstream level have limited the pass-through of increased input costs over the past few years, therefore hurting manufacturing margins. Downstream margins appear to be worsening again of late, as seen in the widening gap between upstream and downstream price gains. In June, ex-factory producer goods inflation exceeded consumer goods inflation by 4.8 percentage points, worsening from 3.7 ppts in May and 2.9 ppts in April. Meanwhile, producers have been suffering a widened gap between raw materials purchasing prices (RMPPI) and their output pricing (PPI). The gap was 2.9 ppts in June, same as that in May and April. Though improving slightly from 3.4 ppts in 1Q, it has proved that the recovery in 4Q05 (2 ppts) is temporary. Lastly, we also look at the gap between CPI and PPI inflation. It may not be an excellent proxy due to the limited direct relation between their basket components, but it does offer a general picture of the consumer market environment. The CPI-PPI margin has also been worsening again, with the gap reaching 1.9 ppts in June, from 1 ppt in May and 0.7 ppt in April. Amid overinvestment and worsening excess capacity, margin pressure is likely to haunt Chinese producers for a while, in our view.
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Rates Left Unchanged
Jul 19, 2006
Deyi Tan (Singapore)
The Central Bank kept rates unchanged at 5.0% in its meeting today. This is in line with our and market expectations. June inflation data supported today’s decision: We think the statement at the Central Bank’s last meeting already set the stage for a pause in monetary tightening. In its last statement, the government said that, provided there are no unexpected developments (especially a continued acceleration of inflation), the MPC viewed 5% as an appropriate level to achieve economic stability and support sustainable growth in the long run. The June data released earlier this month, which showed inflation decelerating to 5.9%YoY from 6.2% in May, supported the decision today and enabled the Central Bank to take some pressure off already weakening domestic demand by not hiking further. Latest statement continues to point to inflationary concerns from oil price volatility: In light of the recent volatility in oil prices and the protracted political gridlock, which still shows no signs of being resolved, the latest statement reiterates that further monetary policy decisions will be contingent on inflation and growth indicators. In our view, rates are likely to be maintained at 5% for the rest of the year. However, there are risks to our steady rate outlook from a potential major oil price rise and/or a vicious global risk reduction trend coming through.
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